FIN 310 - Chapter 16

preferred stock rather than equity

A firm that wants to issue capital but does not want to dilute either the voting rights of existing shareholders or the firm's reported earnings per share may decide to issue ____.

directly

A preferred stock's price is _____ related to the issuer's level of income.

increase

As market yield decreases, preferred stock prices _____.

decrease, increase

As the general level of interest rates moves down, the yields on preferreds _____, and their prices _____.

increase, decrease

As the general level of interest rates moves up, the yields on preferreds _____, and their prices _____.

higher

Cumulative preferred stocks have a ____ value than noncumulative preferred stocks.

less preferred stock does obligate firms to make regular dividend payments but does not offer a tax break

Firms issue preferred stock ____ often than either debt or common equity.

higher

Freely callable preferreds normally provide ____ yields than noncallable issues.

quarterly

Most preferreds pay dividends on a _____ basis.

down

Preferred stock values go ____when inflation and interest rates go up.

trading on interest rate swings strategy

Rather than assuming a "safe" buy-and-hold position, the investor who trades on movements in interest rates adopts an aggressive short-term trading posture that emphasizes capital gains

higher A ratio of 1.0 means the company is generating just enough earnings to meet its preferred dividend payments—not a very healthy situation.

The ____ the fixed charge coverage, the greater the margin of safety.

higher

The higher the dividend payment, the _____ the market price of an issue.

higher

The lower the quality of a preferred stock issue, the ____ its yield.

inversely

The price behavior of a high-grade preferred stock is ____ related to market interest rates.

The issuing company agrees that it will pay preferred stockholders a (minimum) fixed level of quarterly dividends and that such payments will take priority over common stock dividends. The only condition is that the firm generate income sufficient to meet the preferred dividend requirements. However, the firm is not legally bound to pay dividends.

What does the issuing company agree to in terms of paying dividends?

The call price of a preferred stock is made up of the par value of the issue and a call premium that may amount to as much as 1 year's dividends.

What is the call price of a preferred stock made up of?

inverse

What is the relationship between price and yield?

no voting rights

What type of voting rights do preferred shares hold?

fixed charge coverage

a measure of how well a firm is able to cover its preferred dividends

book value / NAV

a measure of the amount of debt-free assets supporting each share of preferred stock

dividend yield

a measure of the amount of return earned on annual dividends and is the basis upon which comparative preferred stock investment opportunities are evaluated

monthly income preferred stock (MIPS)

a special breed of preferred stocks that offers not only attractive yields but also monthly income

preferred stock

a type of security that has some features similar to common stock and other features similar to debt that carry fixed dividends that are paid quarterly and are expressed either in dollar terms or as a percentage of the stock's par (or stated) value

1. does not dilute voting rights of existing shareholders 2. preferred shareholders can't force a firm into bankruptcy

advantages of preferred stock (firm)

1. current income 2. low unit cost per share 3. safety - high grade PS meets dividend payments in a timely manner

advantages of preferred stock (investor)

conversion feature

allows the holder to convert the preferred stock into a specified number of shares of the issuing company's common stock

cumulative basis

any preferred dividends that have been passed must be made up in full before dividends can be paid to common stockholders

1. taxes - firms can't deduct preferred dividends as a business expense

disadvantages of preferred stock (firm)

1. many PS don't qualify for the preferential dividend tax rate (of 15% or less) 2. susceptibility to high interest rates 3. susceptibility to inflation 4. dividends may be suspended, or "passed," if the earnings of the issuer drop off 5. lack capital gains potential

disadvantages of preferred stock (investor)

= annual dividend income / current market price

dividend yield equation

speculating on turnarounds strategy

find preferred stocks whose dividends have gone into arrears and whose rating has tumbled to one of the speculative categories requires fundamental analysis

= EBIT / (interest expense + (pref divd / 0.65))

fixed charge coverage equation

adjustable-rate preferreds

issues that adjust their dividends periodically in line with yields on specific Treasury issues, although minimum and maximum dividend rates are usually established as a safeguard for investors and issuers

in arrears

outstanding unfulfilled preferred dividend obligations firm can't make dividend payments on common shares until preferred stock is paid

= annual dividend income / market yield

price of a preferred stock equation

looking for yields strategy

seeking out those preferreds with the most attractive yields certainty of income and safety

sinking fund provision

specifies how all or a part of an issue will be paid off—amortized—over time

preference stock

stock that has seniority over other preferred stock in its right to receive dividends and in its claim on assets in the event of liquidation senior preferreds

noncumulative provison

the issuing company has no obligation to make up any of the passed preferred dividends still can't make dividend payments to common stock

trust preferreds

type of preferred stock that qualified as debt for tax purposes, meaning that the dividends paid by the issuer could be treated as a tax-deductible expense